We are all well aware that the equity markets have been continuing to touch record levels since October 2023, from around 63k and 19k levels to 81.4k and 24.8k for the Sensex and Nifty, respectively, on the 31 of July 2024.
Consequently, with equity funds also reaching high prices/NAVs, some may want to avoid investing in equity funds and instead look at less volatile options that invest in a mix of equity and debt securities, known as Hybrid Mutual Funds. These funds tend to balance out the market risks and attempt to deliver higher returns than debt funds. They also sometimes include gold or real estate securities.
Difference between Equity and Hybrid Funds
Equity Hybrid
| Degree of Risk | High Risk/Return | Lower Risk than equity funds |
| Returns | Typically higher than Debt Funds, it can be volatile | Returns may vary but are more stable |
| Liquidity | Liquid (except ELSS) | Liquid |
| Suggested Investment Horizon | Long Term (5 to 7 years at least) | Medium Term (3 to 5 years at least) |
| Suitability | Investors with long-term financial goals and high-risk appetite | Investors with medium-term goals and lower risk appetite |
Types of Hybrid Funds
Conservative Hybrid Fund
Conservative Hybrid Funds require the MF to allocate at least 10% to 25% of the total assets to Equity and Equity-related financial instruments, and the remaining 75% to 90% can be allocated to Debt instruments. Debt instruments include fixed income-generating securities such as treasury bills, corporate bonds, commercial papers, certificates of deposits, and others. It is a good option for people looking for debt returns and are willing to take a little extra risk.
Balanced Hybrid Fund
This Mutual Fund scheme invests a minimum of 40% and a maximum of 60% in both Equity and Debt asset classes. Investors looking for long-term capital generation can also opt for a balanced Hybrid Fund, as the debt financial instruments help offset the risks posed by the equity asset class.
Aggressive Hybrid Fund
Under this scheme, investors can invest a minimum of 65% and a maximum of 80% in the Equity asset class. The Debt asset allocation can range from 20% to 35%. By allocating some debt securities in the portfolio, investors can earn higher returns at a reduced risk and benefit from the taxation applicable to equity-oriented schemes.
Dynamic Asset Allocation/Balanced Advantage Fund
This type of Hybrid Fund is suitable for investors who want to automate asset allocation. These funds are dynamic in nature, which means there is flexibility to shift 100% to Debt financial instruments or 100% to Equity asset class. The asset allocation is decided based on the recommendation of the financial model deployed by the fund i.e the asset allocation is automatically generated.
Multi Asset Allocation Fund
This type of fund requires you to invest a minimum of 10% of its portfolio in at least three different asset classes, including Equity, Gold, and Debt instruments. These funds give investors exposure to more asset classes, and the asset allocation is decided based on the view of the fund manager.
Arbitrage Hybrid Fund
This Mutual Fund scheme follows an arbitrage strategy with a minimum of 65% investment in Equity and Equity-related instruments. The arbitrage strategy is buying in the cash market and simultaneous selling in the futures market to generate returns through the price differential between both markets. This is done through derivative instruments, which are categorized as equity-oriented instruments. This fund is suitable for low-risk investors who want to generate debt-like returns with lower equity taxation in a high volatility period.
For details of Arbitrage Funds, please check our earlier article in our blog on the same here: https://ofmoneyandmoney.com/understanding-arbitrage-funds.
Equity Savings Fund
These funds try to balance risk and returns by investing in equity, derivatives, and debt. The equity asset provides growth, and debt and derivatives provide regular stable returns. These schemes invest 65 to 100 percent in equity and derivative assets and 0 to 35 percent in debt asset classes. These are, therefore, positioned between Balanced Advantage and Conservative hybrid funds.
Advantages of Investing in Hybrid Mutual Funds
Hybrid mutual funds offer multiple benefits, making them a popular choice for many investors.
Balance and Stability
Compared to pure equity funds, where the goal is to invest in stocks with higher risk involved, hybrid funds provide a balance. Also, it reduces the chances of such funds performing low by spreading its risk across debt assets and explains lower levels of volatility.
Potential for Capital Growth
The equity portion of a hybrid fund has the potential to generate higher returns over the long term compared to debt funds. This can help you achieve your long-term financial goals, like retirement planning.
Reduced Volatility
By combining equity and debt, hybrid funds experience lower volatility than pure equity funds. This means your investment value might not fluctuate much during market swings, offering some peace of mind.
Things to Consider Before Investing in Hybrid Funds
Understanding the various parameters involved before making investment decisions, like any other investment, is important.
Returns
Ø Hybrid Funds don’t offer guaranteed returns.
Ø The equity and debt market performance will affect the returns to the extent of the fund’s exposure.
Ø The returns of an aggressive-oriented hybrid fund will be more correlated with the equity markets than those of a balanced and conservative-oriented hybrid fund.
Ø Dynamic Asset Allocation funds can move between equity and debt without any caps. They increase/decrease their allocation to equities and debt depending upon the outcome of the financial models based on which the fund is managed.
Risk—Risk means that the volatility of returns in a hybrid fund primarily depends upon the proportion of equity holdings in the portfolio.
Ø The higher the equity component, the more volatile the returns may be. If the market rallies, the returns can be high; if they slump, they can be lower.
Ø In the case of debt-oriented funds, a fund that gets its return mainly from interest income on debt securities may be less risky than a fund that relies on gains from price appreciation. If the fund invests in corporate debt, there are low possibilities of default in these funds as well, which can impact the return of these funds.
Time Horizon—Hybrid funds are suited for a medium-term time horizon, such as 3-5 years. The longer the time horizon, the better the chances of getting stable, higher returns.
Taxation – As per budget 2024/25, the applicable taxation of capital gains will depend on the asset allocation. If more than 65% is allocated to domestic equity or equity-related instruments, the taxation will be as per mutual fund taxation of equity funds.
If the allocation is more than 65% in Sebi-regulated debt and money market instruments, then the taxation will be as per debt funds.
So net-net…Hybrid Funds may be suitable for some who want to reduce their exposure to equity assets by investing in schemes that invest in both equity and debt. The diversification provided by these funds can help control market risks and yield relatively stable profits instead of funds concentrating on a single asset class, especially in the current context of high-equity NAVs.
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